Wednesday, July 27, 2011

Preface: There is an argument for repealing all taxes. I have a strong libertarian streak, and there are arguments that government is wasting our tax money on imperial wars which weaken our national security and other shenanigans. There are also various legal arguments alleging that income taxes are illegal. This essay solely asks how taxes - if we do have them, and given that tax and other government policy has radically redistributed wealth upwards, creating current below-third-world-levels of inequality (greater than seen for many years before the Great Depression) - effect the economy.

Extreme conservatives push for tax cuts ... but just for the wealthy.

Extreme liberals are against all tax cuts, believing that we need higher taxes to pay for government programs ... and that taxes somehow won't create any drag on the economy.

Both extremes are wrong.

In fact, tax cuts for the middle class and poor stimulate the economy, but tax cuts for the wealthy hurt the economy.

This is actually a very simple concept, although some politicians and economists unintentionally or intentionally muddy the waters.

Bruce Bartlett, a Republican political appointee and domestic policy advisor to Ronald Reagan, points out that:

Taxes were cut in 2001, 2002, 2003, 2004 and 2006.

It would have been one thing if the Bush tax cuts had at least bought the country a higher rate of economic growth, even temporarily. They did not. Real G.D.P. growth peaked at just 3.6 percent in 2004 before fading rapidly. Even before the crisis hit, real G.D.P. was growing less than 2 percent a year...

According to a recent C.B.O. report, they reduced revenue by at least $2.9 trillion below what it otherwise would have been between 2001 and 2011. Slower-than-expected growth reduced revenue by another $3.5 trillion.

Spending was $5.6 trillion higher than the C.B.O. anticipated for a total fiscal turnaround of $12 trillion. That is how a $6 trillion projected surplus turned into a cumulative deficit of $6 trillion.

Bartlett offers this killer chart as a summary of the numbers:

If you recall, it was George W. Bush’s father, GWH Bush, who, when campaigning against Reagan, called supply side economics’ claims that tax cuts pay for themselves Voodoo Economics. And Bush was proved right when deficits spiralled out of control and both Reagan and Bush were forced to raise taxes.

***

The Bush tax cuts accrued disproportionately to the wealthy. The Tax Policy Center shows that 65 percent of the dollar value of the Bush tax cuts accrued to the top quintile, while 20 percent went to the top 0.1 percent of income earners.

Families earning more than $1 million a year saw their federal tax rates drop more sharply than any group in the country as a result of President Bush’s tax cuts, according to a new Congressional study.

The study, by the nonpartisan Congressional Budget Office, also shows that tax rates for middle-income earners edged up in 2004, the most recent year for which data was available, while rates for people at the very top continued to decline.

Based on an exhaustive analysis of tax records and census data, the study reinforced the sense that while Mr. Bush’s tax cuts reduced rates for people at every income level, they offered the biggest benefits by far to people at the very top — especially the top 1 percent of income earners.

The Bush-era tax changes conferred disproportionate benefits to those at the top of the earnings distribution, exacerbating a trend of widening income inequality at a time of already poor wage growth.

***

The top 1% of earners (making over $620,442) received 38% of the tax cuts. The lower 60% of filers (making less than $67,715) received less than 20% of the total benefit of Bush’s tax policies.

The Bush-era tax cuts were designed to reduce taxes for the wealthy, and the benefits of faster growth were then supposed to trickle down to the middle class. But the economic impact of cutting capital gains rates and lowering the top marginal tax rates never materialized for working families. Inflation-adjusted median weekly earnings fell by 2.3% during the 2002-07 economic expansion, which holds the distinction for being the worst economic expansion since World War II.

First, the rich spend a smaller proportion of their wealth than the less-affluent, and so when more and more wealth becomes concentrated in the hands of the wealth, there is less overall spending and less overall manufacturing to meet consumer needs.

Second, in both the Roaring 20s and 2000-2007 period, the middle class incurred a lot of debt to pay for the things they wanted, as their real wages were stagnating and they were getting a smaller and smaller piece of the pie. In other words, they had less and less wealth, and so they borrowed more and more to make up the difference. As Reich notes:

Between 1913 and 1928, the ratio of private credit to the total national economy nearly doubled. Total mortgage debt was almost three times higher in 1929 than in 1920. Eventually, in 1929, as in 2008, there were “no more poker chips to be loaned on credit,” in [former Fed chairman Mariner] Eccles' words. And “when their credit ran out, the game stopped.”

And third, since the wealthy accumulated more, they wanted to invest more, so a lot of money poured into speculative investments, leading to huge bubbles, which eventually burst. Reich points out:

In the 1920s, richer Americans created stock and real estate bubbles that foreshadowed those of the late 1990s and 2000s. The Dow Jones Stock Index ballooned from 63.9 in mid-1921 to a peak of 381.2 eight years later, before it plunged. There was also frantic speculation in land. The Florida real estate boom lured thousands of investors into the Everglades, from where many never returned, at least financially.

Tax cuts for the little guy gives them more "poker chips" to play with, boosting consumer spending and stimulating the economy.

Giving the stimulus to the debtors is a more potent way of reducing the impact of a credit crunch [than giving money to the big banks and other creditors].

And as discussed above, Reich notes that tax cuts for the wealthy just lead to speculative bubbles ... which hurt, rather than help the economy.

Indeed, Keen has demonstrated that "a sustainable level of bank profits appears to be about 1% of GDP" ... higher bank profits lead to a ponzi economy and a depression. And too much concentration of wealth increases financial speculation, and therefore makes the financial sector (and the big banks) grow too big and too profitable.

For those who still claim that tax cuts for the rich help the economy, the proof is in the pudding. The rich have gotten richer than ever before, and yet we have Depression-level housing declines, unemployment and other economic problems.

You talk about "the rich" as if they are some kind of static group of people when it reality it’s a group in flux like any other group. Clinton was poor when he left office; he subsequently became rich through book deals and speaking. Obama became rich similarly. Did these guys make someone else poor by becoming rich? Did they add no value to society for the products they produced? You can't answer that because you have no clue. The only people that can answer that are the people that paid for their books or to hear them speak.

Anyhow, what about people like me that own a business and are trying to become wealthy? In periods of high growth, high ordinary income tax rates impact my business by taking funds from valuable working capital and sending them off to the government. I am then forced to go to the bank or private investors and sell my soul and even some of my business to get the money I need to grow with.

At the beginning of 2000 I took my savings and started a new business. By 2009 I had built up a company that employed 27 professionals. In 2010 my company took a dive and my line of credit secured by my home, was cut off which forced me to put in my saved money to save it.

After 6months of paying people to sit around, I ended up having to cut over 1/3 of my workforce, but saved the company. It will take me years to get my money back, but if I didn’t have that money because I was paying much higher taxes as people like you and Reich seem to think are so good, I would have had to cut most of my workforce and much sooner. I can’t for the life of me understand how either of you think a healthy economy can exist without substantial savings. I also don’t understand how either of you think that investment is inspired by lowering returns with increased taxes.

When I read stuff like this or listen to the President's redistributionist rhetoric, it doesn't encourage me to take risk but actually to do the opposite and that is to protect the wealth I do have, since as taxes rise it will be harder to replace should I lose it. As Steve Wynn (a democrat) recently said, this President is a “wet blanket” which is the sentiment of every small business owner I talk with these days. Most of us are scared to death of what is going to happen with healthcare costs when Obamacare is implemented and now we are told we can work harder and take more risk for less possible reward. No thanks!

People go into business for all sorts of reasons, but the one thing that keeps all of us in the game is the belief of one day we can achieve financial independence. When you talk about raising taxes on the rich, you are also decreasing the incentive for the small businessman to stay in the game. Why would any thinking person ever want to start a business, take all the risk and deal with all the head aches when the reward is the more successful I am is to have government (state and federal) become my 50% partner in my profits? Again, no thanks, I’ll take a desk job instead.

I guess what I find most extraordinary is that Reich and you completely ignore the impact of Fed policy during the last three decades. The Feds cheap money policy (similar to the 20’s under B.Strong) has done more it encourage public and private debt growth then probably any other policy made by government. This cheap money policy I think is a far better explanation of the root cause of why there has so much speculation, wealth inequality and enormous amounts of consumer debt during the last 30 years then simply people trying to create the appearance of wealth. Cheap money inspired people to spend rather then save. Cheap money forced people into the risk trade to gain yields not available on safe investments. Essentially, it fed Wall Street as it is still doing today.

I think Reich's work is intellectually dishonest and the product of selective analysis and extreme reductionist thinking.

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